APB accounting principles: volume 2: Original pronouncements as of June 30, 1973

Page 594

No. 7 9639
Deferred Compensation Contracts UNOFFICIAL ACCOUNTING INTERPRETATIONS
1. Accounting for Key-Man Life In­surance
Question—Is the “ratable charge” method of accounting for the cost of nonterm life insurance policies on corporate officers an acceptable accounting method?
Answer—No, the ratable charge method is not acceptable for use by a corporation to account for the cost of officer’s life in­surance policies. Under this method, the net cost of the policy (total premiums to be paid minus total cash surrender value for a paid-up policy is amortized over the life of the policy) by the straight-line method, producing a “level” annual charge. The method assumes that a critical unknown— the length of time an officer will remain in the corporation’s employment—can be pre­dicted with much greater certainty than is usually justifiable. If the policy should be discontinued prior to the payment of all scheduled premiums (for example, because of termination of the officer’s employment or a change in management’s policies), the ratable charge method would result in a
“writeoff” of a large unamortized deferred charge.
The generally accepted method of ac­counting for nonterm insurance on the life of a corporate officer is to charge the in­crease in the cash surrender value of the policy to an asset account and to charge the remaining balance of the annual pre­mium to expense. Advocates of the ratable charge method cite the large charges to expense under the generally accepted method in the early years of a policy as being too conservative and inconsistent with the “match­ing” and “going concern” concepts in ac­counting.
Admittedly the generally accepted method is conservative, but it reflects the economic realities of the transaction. And “matching” should not be confused with “leveling.” Finally, the going concern concept recog­nizes that businesses continue in existence, but the fact that a business continues is not an argument for deferring costs unless a future period will in fact be benefited.
[Issue Date: November, 1970]
APB Accounting Principles